Inequality doesn’t matter: a primer

So Jeremy Corbyn’s talking about inequality. His ideas might be a little silly, but at least he’s talking about inequality, right?

Well, no – inequality probably isn’t something we should worry about at all. The fact that Corbyn's policy is solely designed to make the rich poorer just shows what a pointless measure inequality actually is.

Most people use it as a shorthand for living standards for poor and average-income workers, but inequality measures are just as sensitive to the incomes of the people at the top as the bottom. That means that if everyone becomes worse off, but people at the top become even worse off than the rest, then inequality falls. That’s what happened during the Great Recession, where inequality (as measured by the “Gini coefficient”) actually fell. 

OK, but that was a little blip. Everybody knows that income inequality is higher than ever, and getting worse.

Actually, the data says otherwise. Income inequality in the UK is now at its lowest level for thirty years, according to new data from the Office for National Statistics.

That doesn't sound right. What about wealth inequality?

That’s actually been on a huge downwards trend for the past one hundred years! And the wealth share held by the top 10%, top 5%, top 1%, even the top 0.5% and 0.1% has been static since the 1980s after a long decline during the 20th century – see the chart below. And during that time wealth per adult has increased massively, which means that people in the middle have seen huge gains.

You say that, but it’s obvious that some people at the top are getting much richer while most of the rest of us haven’t had a pay rise since the financial crisis.

It’s true that some of the top earners have seen huge pay rises over the past decade – FTSE 100 chief executive pay has nearly doubled. But that’s an absolutely tiny group: one hundred people out of a workforce of 32 million. That isn't the 1%, that's the 0.0003125%. What is true is that most people haven’t seen much of a pay rise for many years, and that seems to be what’s really the matter here.

People aren’t just mad about inequality – they’re mad about the unfairness of people getting bigger paycheques undeservedly while their employees get no rise at all.

It doesn’t look as if it’s undeserved, for the most part. Chief executives matter a lot – the strategic decisions they make affect every part of the firm they run, and it makes sense for a firm to spend several million if that’s what it takes to attract the top talent. Some think these pay packets are evidence of rent-seeking by executives, but financial markets seem to be very sensitive to the appointment and resignations of chief executives, suggesting that people with money on the line think that they matter a lot to firm value. And market movements after CEO deaths (both negative, after good CEOs die, and positive after bad ones die) have been getting larger and larger since the 1950s – a sign that they matter more and more to their firms, maybe because globalisation means top-level decisions matter more these days. It makes sense that big corporations would be willing to spend a couple of million quid for a chief executive that adds half a billion to the value of their firm, doesn’t it?

What’s more, it’s just not the case that cutting the wages of people at the top will boost the wages of people at the bottom. Companies spend what they need to to get resources they need – they don’t just have a big pot of money to spend on things. If we banned firms from spending more than a certain amount on IT services, we wouldn’t expect the money they had left over to go into workers’ wages, and we might find that the firms were less productive overall. Capping chief executive pay is similar to that.

Even if inequality has been falling, it’s still relatively high in the UK and the OECD and the IMF both say that inequality can slow down growth. Surely you accept that?

I’m afraid not. These studies tend not to be very high-quality, doing international ‘cross sectional’ comparisons that compare countries in a moment in time. That means that they end up comparing Sweden with Mexico, leaving out a lot of other factors that might be the cause of both Sweden’s lower inequality and its lower crime and poverty rates, and assuming what they’re trying to prove. But even though countries with lower inequality might have higher growth rates, that doesn’t mean that cutting inequality will boost growth rates.

A better method would be to do time series comparisons that look at what happens within particular countries when inequality rises or falls. A paper by Kristin Forbes that did that found that, actually, “an increase in a country’s level of income inequality has a significant positive relationship with subsequent economic growth.” Another paper, which tries to control for lots of the factors that usually confound results like the IMF’s and OECD’s, finds that across US states lower inequality is associated with lower subjective wellbeing.

My friend, the mysterious “Anonymous Mugwump”, points to evidence that wealth inequality caused by market factors, as opposed to cronyism, doesn't seem to be related to low growth, and that in African states higher inequality levels don't seem to be related with low growth either.

But inequality does undermine the social fabric of the country. You can’t put a price on that.

Does it? As Ben points out, a 2012 paper that looked at survey data from all 34 OECD countries over 30 years found no effect from inequality on honesty, altruism or civic-ness, very little effect on obedience or tolerance, and a positive effect on work ethic. Nor does inequality seem to allow the rich to buy elections – indeed most of the evidence suggests that, contrary to popular opinion, it’s very hard to buy an election. Donald Trump might have been a billionaire but it was his fame, not his money, that helped him win the election – he ran one of the cheapest campaigns of recent times and beat one of the most expensive ones.

Haven’t you read the Spirit Level? It contradicts everything you’ve been saying, and it’s evidence-based.

It’s bunk. Christopher Snowdon has demolished practically every important claim in the book, from inequality causing shorter lifespans to higher murder rates to unhappier citizens to less charitable giving, with most coming from “highly selective use of statistics” (to quote The Economist) – leaving out inconvenient countries to create the impression of a trend where there is none.

If what you’re saying is right, why does everyone care so much about inequality? Doesn’t their preference for more equality matter?

The great fact about inequality that most people who talk about it won’t admit is that people are very very bad at judging how unequal their societies actually are. An amazing paper asked people in all sorts of different countries, rich and poor, equal and unequal, to choose which ‘picture’ of society, below, was closest to showing the shape of incomes in their own society.

Globally, respondents were able to pick the “right” diagram only slightly better than randomly – 29% got it right, compared to a random baseline of 22.5%. Accuracy differed significantly between countries: 61% of Norwegians got it right, 40% of Britons did, 5% of Ukrainians did. In only five countries out of forty did more than half of respondents guess correctly. (All this uses post-tax-and-transfer data; people’s accuracy is much worse if you use pre-tax-and-transfer data.)

And respondents weren’t even close – looking at how many people were only one diagram off the right one, respondents only did one percentage point better than random (69% versus 68%). As the authors note, “with only five options to choose between, getting within one place of the correct option is not a very difficult task”. Except for a few Scandinavian countries, people’s perceptions of inequality in their own country were barely better than random. That means that loads of the objections people have to inequality, if there is any truth to them, are probably actually objections to perceptions of inequality, which may be more driven by media coverage than reality. If that’s true, then trying to reduce inequality in fact is a waste of time – you should try to get the media to talk about it less instead.

Surely there’s nothing actually wrong with reducing inequality though, even if it doesn’t achieve much?

It depends on how you do it. Taxes are not created equal. Taxes on capital will depress investment and, according to most economic models, growth. This isn’t a right-wing point – Joe Stiglitz and the late Tony Atkinson, who both thought that inequality was a problem, worried that capital taxes would actually make the welfare of people at the bottom worse by reducing growth. Since income tax is a tax on both earnings that people invest and that they consume, it is another form of capital taxation in its current form. We think the best solution would be to exempt savings and investment from taxation altogether, and tax people when they consume their wealth – which would allow us to tax the rich in greater proportion to the poor, but wouldn’t hurt growth.

So are you saying you don’t care about inequality at all? Isn’t that very heartless?

It’s not inequality that matters, it’s poverty and overall living standards. The real problem we’ve had since 2008 is that median earnings have barely risen since then at all, and the cost of living has risen for people across the board. In particular, housing costs eat a large chunk of most people’s incomes, and most homes in Britain are small and pokey compared to those in continental Europe and in the United States. It’s not for want of space – only 2% of England is built on – it’s because we have incredibly restrictive planning laws that restrict the supply of land to build on. House prices in the South East could be 30% lower if planning laws were less strict.

Changing things like that, and changing the tax system so we can get more economic growth, are the best ways to reduce poverty and improve people’s lives. I'm in favour of just giving poor people money, whether through tax credits or something more radical like a basic income or negative income tax, too. The point is to raise up people at the bottom, not cut down people at the top.